What is Vendor Risk Management and How Does it Work?

Vendor Risk Management

In business, language is important. The understanding of language and its intent can mean the difference between a sale and a loss. It can also mean the difference between good contract performance, and contract failure. There is a lot to be gained by being specific and accurate in the use of business terminology, then – especially when it comes to the proper management of risk. Chief among terminology types, in this respect, is the way we describe the source of the risk.

For many businesses, the terms used to describe the source of risk are interchangeable, but a high degree of specificity can yield quantifiable results. In some cases, the term ‘Third Party’ is used as a catch-all to describe all external organisations and individuals with whom the business connects, including clients and suppliers. However, by employing different terms for different types of business relationship, greater efficiency and control can be achieved within the business practice. This means using the term ‘supplier’ to indicate the source of physical goods and materials, and the term ‘vendor,’ or ‘service provider,’ to denote the source of IT services.

What is Vendor Risk Management?

Having established the meaning and importance of the term ‘vendor,’ in business, how does the concept of the vendor relate to business risk? Every time a business forges a new relationship with an external organisation or individual, risk is created. A point of vulnerability is generated in the structure of the business. This is because the business is made reliant upon the integrity of the external organisation or individual; upon the ability of the external organisation or individual to fulfil obligations and meet all internal and external requirements. If the external organisation or individual fails in any of those areas, the original business is negatively impacted.

If a business enters a new commercial relationship with an IT provider as a vendor, for example, and that IT provider falls victim to a cyber-attack, then the original business is also at increased risk. The perpetrators of the cyber-attack may also gain access to commercially sensitive information regarding the business relationship or may even be able to exploit the vulnerability generated by the relationship by launching a cyber-attack on the original business. At a minimum, the service provided by the IT provider is likely to be disrupted, potentially causing difficulty to the original business in terms of its ability to fulfil its own client obligations.

We can see from these types of scenarios that, like all business risk, vendor risk has the potential to cause significant financial loss to the business. That can be direct loss of revenue, resulting from service disruption or financial penalty caused by delays in delivery. Longer term financial losses can result from associated reputational damage, data breaches or theft of intellectual properties.

Businesses outsource operational elements - such as IT services - to save money. In certain circumstances, it can cost less to engage outside services than to expand and utilize the businesses own resources and infrastructure. But this type of saving is only consolidated in that optimal way if the risk associated with vendor is properly managed in an effective and thorough fashion because the process of Vendor Risk Management builds efficiencies into the processes of business. These efficiency gains, coupled with reductions in real and potential losses, are why Vendor Risk Management is so important in business.

How does Vendor Risk Management work?

Like all Risk Management, Vendor Risk Management is about identifying and assessing risk, and making decisions based upon an understanding of the potential impact of each risk on the business. To begin this process with regard to vendors, the business must first explore the concept of risk thoroughly and determine both the risk appetite and the risk tolerance of the business.

  • Risk appetite – This is the actual level of loss that the business can withstand while still functioning on a day-to-day basis.
  • Risk tolerance – This is the level of flexibility that is possible around the risk appetite. It can be thought of as a buffer, or risk cushion, and indicates the amount of risk fluctuation that the business is able to withstand.

There will be many factors that influence the determination of risk appetite and risk tolerance, but they will be heavily affected by the integrity of the business approach to Risk Management processes, including the security of both physical and digital infrastructure.

Having determined the risk appetite and risk tolerance of the business in relation to vendors, the risk assessment process can begin. This involves the identification of risk and is something that is specific to each business. This means it is also specific to each vendor. Risks identified will depend upon the nature of the vendor, its position within the global market, and the type of service it is providing. Risk will also depend upon the nature of the relationship between the vendor and the business. For example, if the business and the vendor enjoy a particularly close relationship – if the vendor is known to the business through years of collaboration – then risk will be identified differently than if the vendor is entirely new to the business. This is because the variables relating to risk within a close, long-standing business relationship are easier to identify.

The Vendor Risk Management Lifecycle and the role of contracts

The goal of any business must be to develop an effective Vendor Risk Management program. This can mitigate the risk associated with all vendors in an efficient way, moving forward. To establish a program that can work retrospectively on existing vendors, as well as for those being onboarded in the future, it is first essential to understand the Vendor Management Lifecycle, and the role played by contracts.

All business relationships are governed by contracts, and this includes vendor relationships. If a vendor is onboarded, it is because that business is providing a service of some kind, and the terms of that service must be set out clearly in a legal agreement. The most effective Contract Management approach is to view each agreement as a lifecycle, and this approach also applies to Vendor Risk Management. Each vendor relationship can be handled as having specific lifecycle stages that broadly align with the stages of Contract Lifecycle Management.

1. Identification

The first stage of the Vendor Lifecycle is the identification of the vendor. This will match the Contract Lifecycle stage of requesting a contract, or putting a business need out to tender. Once the business need has been identified – the need for an IT solution, for example – then a range of potential vendors need to be identified against criteria set by the business. This identification criteria may include price range, added value, availability, and quality of submission.

2. Selection

Vendors are selected based upon their assessment against the set criteria, which is essentially the first step in risk mitigation. Ensuring that the vendor can meet the need of the business is the initial elimination of risk, because it already increases the likelihood of the new vendor relationship being productive in the required way.

3. Risk assessment

The risk assessment stage requires the detailed exploration of risks that are specific to the selected vendor and specific to the nature of the proposed relationship. To complete a thorough and accurate risk assessment, every eventuality must be considered. This requires the completion of extensive background checks on individuals as well as the organization itself, and a detailed investigation of the processes and capabilities of the vendor in question.

4. Risk mitigation

Once risks have been identified and assessed, they need to be examined within the context of the risk appetite and tolerance of the business. This allows for appropriate and effective overall risk mitigation measures to be applied. Depending on the type of risk, these measures might include:

  • Avoidance – Withdrawing from the process, or declining to get involved, due to risk being assessed as too high.
  • Reduction – Optimize or mitigate the risk by reducing the severity of potential loss.
  • Transfer – Share or outsource the risk further.
  • Retention – Accept the risk and budget for any potential loss using the risk appetite and tolerance as an assessment and decision framework.

5. Contract

With all Risk Management decisions made from a fully informed perspective, the vendor relationship can proceed to the contracting stage, in which terms are agreed that stipulate the scope of the relationship, and the obligations of all parties. It also enables the business to engage in any procurement processes that are necessary to firstly secure the vendor, and to address any additional need. For example, if the risk reduction measures require specific infrastructure or resources, these may need to be procured. Once the contract is activated, the vendor relationship is live.

6. Monitoring

Just as the monitoring of contract performance is vital for maintaining close control of timescales, obligations, and deliverables, so the monitoring of the Vendor Risk Management Lifecycle or vendor relationship is also an effective way to ensure efficiency and productivity. All business risk changes over time and vendors are subject to fluctuating risk around their own operation. These changes make the constant and consistent monitoring of vendor risk an essential part of any Risk Management process. It allows for ongoing risk assessment and the adjustment of risk profiles in response to changing circumstances which, in turn, ensures that all decision-making is based on accurate data.

7. Evaluation

When the contract governing the vendor relationship reaches the end of its lifecycle, there is a process around decisions regarding termination, renegotiation, and renewal. Decisions around the vendor are also needed at this stage and involve a comprehensive evaluation of the success of the collaboration over time. The purpose of these decisions is to determine whether the categorization of the risk associated with that vendor relationship has changed in the context of the risk appetite and tolerance of the business. Are they still a vendor the business can safely connect with, or should the relationship be terminated? Should that vendor be offboarded and, if so, what does that process need to look like to protect commercial interests?

The importance of a software solution

Today, the move toward digital solutions is everywhere in business, and for good reason. Productivity and profitability are significantly boosted by increases in efficiency throughout any commercial operation. Processes happen faster and with a higher degree of accuracy, not least because the inclusion of AI technology in modern software specifically automates basic tasks – greatly reducing the risk of human error. It is this aspect of software that makes such technology the ideal solution for any business area that deals with risk.

The implementation of Risk Management systems is a risk reduction step in itself, because it ensures that the awareness of both risk and the potential consequences of the same are prioritized in day-to-day operations. The implementation of high quality, comprehensive digital solutions for Risk Management ensures that the business has every tool required to manage all risk, including vendor risk, in a way that is responsive and scalable.

Symfact has designed a fully customizable software platform that delivers optimal Risk Management functionality, including everything needed for thorough and effective Vendor Risk Management. Using cloud technology and permission-based access protocols, this browser-based product ensures that all authorized personnel can access the platform from any web-enabled device in any internet connected location – speeding up the Risk Management process in a way that boosts efficiency throughout the business.

Specific features include

  • Centralized repository – All documentation is stored digitally in a secure, centralized location. This essentially transforms the business library into a powerful and valuable data source that is fully searchable.
  • Intelligent questionnaires – Risk assessments and risk profiling is made faster and simpler with tools and bespoke templates to design, build and publish intelligent questionnaires. These provide a flexible framework, informed by the risk appetite and tolerance of the business, against which all proposed new business relationships can be assessed.
  • Background checks – Links are available within the software to all leading external databases, including LexisNexis, Dow Jones, Dun & Bradstreet and Thomson Reuters. This allows the business to perform comprehensive background checks on organizations and individuals to surface all necessary risk information. This can provide increased protection against corruption, cybercrime, financial misconduct, Politically Exposed Persons, and association with acts of slavery.
  • Automation – Processes including reporting, workflow management, and auditing all include a high degree of automation, which means that accuracy and speed is vastly improved, and risk is reduced.

Contact Symfact today to arrange your demonstration, and to find out how your Vendor Risk Management can be enhanced.